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re: re: st: Correction for overlapping return series


From   Malcolm Wardlaw <malcolm@mail.utexas.edu>
To   statalist@hsphsun2.harvard.edu
Subject   re: re: st: Correction for overlapping return series
Date   Wed, 10 Feb 2010 21:02:13 -0600

Thanks for this. I read Hansen-Hodrick, but couldn't figure out if the Newey-West correction was actually doing the same thing with an MA error. Is there any practical difference in the two, aside from the fact that NW guarantees a positive definite covariance matrix?

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Hansen, L.P., Hodrick, R.J.. "Forward Exchange-Rates As Optimal Predictors of Future Spot Rates - An Econometric-Analysis." Journal of Political Economy 88: 829-853, 1980.

Essentially if you overlap by 12, you are creating a MA(11) in the errors. (The more common issue, three-month T-bill rates observed monthly, gives rise to MA(2)). So applying a HAC estimator (e.g. Newey-West) with lag length = 11 should do it. Yes, this models the errors as AR(11) rather than MA(11), but it works. You can do this with -newey-.
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